3 minute read
Volatility and downward pressure
from #229 - April 2020
We take a look at how the pandemic affects corporates and the financial system as a whole
COVID-19 has had an unprecedented domino effect on economies over the last few weeks. Governments, multi-national organisations and central banks have all rallied to contain the repercussions of the pandemic.
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“The pandemic has put an abrupt end to one of the longest bull-runs in history,” said Mathieu Vasseux, Head of Financial Services MEA at Oliver Wyman.
Speaking exclusively to Banker Middle East, he explained, “The massive gains of 2019, with many markets gaining 30 per cent have already been erased. To soften the impact, central banks have intervened by directly purchasing assets from not only banks but also investors, like Bank of Japan, offering repo of a wide range of securities including commercial paper and stocks, performing currency interventions, liquidity injections across the financial system and interest-rate cuts to zero almost across the board for developed countries.”
In a recent statement released by Fitch Ratings, the direct impact the outbreak may have on a financial institution’s operations include: 1) Funding and liquidity pressures as well as market valuation losses arising from dramatic movements in the capital markets; 2) A decline in asset quality or market value that may result from exposure to highly affected corporate sectors or as a result of consumer or commercial borrower payment forbearance, delinquencies or defaults; 3) Revenue pressures arising from lower business volumes; 4) The impact on spread and investment earnings from depressed interest rates; 5) Lending and trading activities especially vulnerable to sharply lower oil prices; 6) For insurance companies—the impact of stock market volatility on investment values and capital as well as the impact of heightened insured claims; and 7) The impact of current or potential monetary policy easing, regulatory stimulus, fiscal stimulus, or direct government or parent support.
“The impact of COVID-19 will lead to a steep deterioration of credit quality as corporate revenues and personal incomes face a deep decline due to travel restrictions and quarantine measures seen across the globe including the Middle East,” said Vasseux.
He said that most large corporates are drawing their full credit lines similar to the recent announcement from Boeing. Others are trying to issue debt, but only the highest quality names can issue in this market environment and at spreads 200bps higher than a few weeks ago. As such, this will increase the prospects of defaults and banks in particular will suffer more losses.
“The pandemic will also result in higher funding cost, and we already see funding costs double in the high yield segment as issuances slow. We already witnessed a doubling of credit spreads in many segments of high yield,” he added.
The reduction of interest rates by central banks may provide some welcome relief reducinng funding stress for banks, monetary easing will not have a direct impact on supply chains nor will it erase the impact of quarantining on businesses. Vasseux urged governments to prioritise fiscal stimulus packages that could soften the impact of COVID-19.
He said, “In light of the disruption of the global economy and intervention of central banks, businesses should work towards implementing short-term risk management and mitigations to manage the credit cycle’s rapid shift. This includes adopting early warning systems, collateral management, recoveries and remedials. Legally, many clients might invoke force majeure, which could reduce banks’ recovery ability and trigger complex legal proceedings.”
Mathieu Vasseux, Head of Financial Services MEA at Oliver Wyman
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